What you need to know about the territorial restrictions that apply when opening a new outlet

March 13, 2018

For several years now, fewer and fewer franchise agreements include exclusive territory clauses for the benefit of the franchisee.

This can cause development problems for the franchisor. Some of those problems stem from:

granting exclusive territories that are too large (particularly for the first franchisees);

unforeseen changes (demographic and otherwise) in the markets to which an exclusivity applies;

the arrival of new magnets for customers (shopping centres, etc.) in a territory that is subject to an exclusivity;

faster growth than was foreseen in the business done at each franchise outlet;

restrictions imposed by exclusivity clauses on opportunities to sell products through channels other than the franchise network (for example, online, in grocery stores and big box stores, etc.) or in partnership with other companies (for example, by installing kiosks or counters in another chain's store); or

restrictions imposed by exclusivity covenants on opportunities to purchase existing businesses and on selling, buying or merging networks.

Today, many franchise agreements no longer provide, in favour of franchisees, any kind of territorial exclusivity, while others limit exclusivity to the building (or even the premises) in which the franchisor operates its business. Some contracts even say that the franchisor, in its absolute discretion, may open new outlets at any location it chooses, including in immediate proximity to the franchised business.

Nonetheless, if the franchise agreement does not provide for any exclusivity in favour of the franchisee, does that mean the franchisor has the right to open a new outlet anywhere it chooses, even in immediate proximity to a franchisee's business?

The answer to the question is: yes, but...

Because a court cannot rewrite a contract, it cannot impose a duty on a franchisor to grant a franchisee an exclusive territory (unless the court finds a clause in the contract that allows it to do that).

However, according to the judgment of the Quebec Court of Appeal in the famous Provigo case, a franchisor has certain implicit obligations to its franchisees that arise out of the nature of the franchise relationship itself. They include (a) an obligation of good faith and fair dealing owed to its franchisee, and (b) an obligation to provide ongoing technical and commercial assistance to the franchisee,
in a spirit of partnership and collaboration, to enable the franchisee to reap the benefits of the contract it has signed.

The Court of Appeal also held that a court cannot add an exclusive territory clause to a contract that is not already written into it.

The initial answer to our question is therefore that, even if it might not always be a wise decision, when the franchise agreement does not provide for any exclusivity or other territorial protection in favour of the franchisee, the franchisor is at complete liberty to open a new outlet anywhere it chooses, even in immediate proximity to a franchisee's business.

However, if the new outlet could damage the sales or profitability of an already established franchise, the franchisor also has an obligation to make arrangements that will enable it to continue to meet its "obligation to provide ongoing technical and commercial assistance to its franchisee". In those circumstances (as in any other situation), the franchisor must also be able to prove that it acted in good faith (and not, for example, with the aim of harming its prior franchisee).

A franchisor that is then not able to continue meeting its obligations to its prior franchisee runs the risk of legal action (for damages and for termination of the contract) by the franchisee.

What this means is that these are often very delicate situations.

In some cases, it is preferable to include an exclusivity clause in which the territory is specifically limited to the franchise outlet's primary market and provide the necessary exceptions and exclusions, so as not to unduly hinder the growth of the network of franchises, rather than take the seemingly easy route (at least at the time the contract is drafted) of not including any exclusivity clause.

Each situation must therefore be assessed on its merits based on a variety of factors, including the industry in which the franchise network operates and the size of the franchisee's investment.

Fasken has all the expertise and resources that are needed to help you to design, plan, prepare and implement a business model and structure and the agreements that are genuinely tailored to meet your needs.